RESEARCH
Brief
Michigan
Retirement
Research
Center
University of
Macroeconomic Conditions and
Updating of Expectations by
Older Americans
Purvi Sevak and Lucie Schmidt*
November 2011
Economic theory suggests that individuals’ decisions about consumption, saving, and labor supply should be directly linked
to subjective expectations about future events. Expectations of older cohorts of individuals are particularly important to
examine, given the importance these expectations are likely to play in retirement planning and timing decisions that are
costly to reverse.
In this paper, we investigate expectation formation, using data from the 1994–2008 Health and Retirement Study (HRS) linked
to data on local and national macroeconomic conditions. We examine a number of different expectation questions that can
be categorized into two groups. A set of macroeconomic and public policy questions includes expectations that the U.S.
economy will have a major depression within the next ten years; that mutual fund shares invested in blue chip stocks will rise
in value over the next year; that Social Security will become less generous; and that there will be double-digit inflation within
the next ten years. A second set of questions related to individual-level situations includes respondent-reported probabilities
of working full time after age 62 and 65 (asked of those respondents younger than age 61 and 64, respectively); of leaving an
inheritance of $10,000; and of medical expenses using up all of the respondent’s savings in the next five years. All expectation
questions have been asked for multiple waves, allowing us to utilize multiple responses across years for a given respondent.
We merge in state-level data on monthly unemployment rates, quarterly house price indices (HPI), and quarterly data on job
creation and loss. We also merge monthly stock price data from the S&P 500 and monthly retail sales data at the national
level. We exploit the fact that through restricted access, HRS makes available the month an individual respondent’s interview
began. This allows us to more precisely match economic conditions at the time of the interview, and provides greater
variation with which to estimate responses.
We use these data to estimate the relationship between each of these expectation variables and national and local economic
conditions, while controlling for demographic characteristics and state of residence. We include year fixed effects to capture
national changes in macroeconomic conditions over time. We include the monthly and quarterly macroeconomic measures
mentioned above to test whether subjective expectations vary with local and higher frequency macroeconomic indicators.
Finally, we interact these variables with an indicator for college-educated to test whether the updating of expectations by
households in response to these conditions varies by education level.
Findings
We find strong correlations between a number of demographic characteristics and individuals’ expectations about both
macroeconomic and policy events, as well as about future individual labor supply and financial wealth. Individuals in poor
and declining physical and mental health have significantly less optimistic expectations about the macroeconomic future.
Individuals from more vulnerable socioeconomic groups have lower expected probabilities of leaving bequests and higher
* Purvi Sevak is an associate professor of economics at Hunter College at the City University of New York. Lucie Schmidt is an associate
professor of economics at Williams College. This Research Brief is based on MRRC Working Paper WP 2011-259.
expected probabilities of having medical expenses use up their savings. However, they are also significantly less likely to
expect to be working past age 62 or 65, which could have important implications for their economic well-being.
We also find evidence that suggests that HRS respondents update their expectations in response to local and high frequency
macroeconomic conditions in ways that seem to make sense. Our results suggest that individuals revised their expected
probability of a major depression upward substantially during 2008, the onset of the current economic downturn. Higher state
unemployment rates and a decrease in average monthly stock prices are also associated with a significant increase in the
expected probability of a depression. We find that higher local unemployment rates are significantly associated with a higher
expectation of less generous Social Security, as are increases in retail sales prices. Our results also suggest that an increase in
stock prices is significantly associated with a decreased expectation of a future stock price increase, which could be consistent
with beliefs in some degree of mean reversion in stock prices. Increases in job gains are significantly associated with inflation
expectations, with higher job gains leading to higher expectations of double-digit inflation.
We also find evidence of heterogeneity by education in the response to local macroeconomic conditions. For example, for
college graduates, the effect of an increase in the unemployment rate on the expected probability of a depression is twice
the magnitude for college graduates than for respondents with lower levels of education. College graduates revise their
expectations of a depression upward in response to an increase in job losses, a decrease in retail prices, and an increase in
housing prices. However, the expectations of college graduates about a less generous Social Security system are less likely to
respond to economic conditions.
We also find that local and recent macroeconomic conditions are correlated with subjective probabilities of one’s own future
behavior. Increases in the house price index are significantly associated with the decreased expected probability of working
past the age of 62, though other macroeconomic variables do not seem to matter. However, the expected probability of
working past the age of 65 is more responsive to economic conditions. Increases in the unemployment rate and decreases
in job gains are both positively and significantly associated with the expected probability of working past the traditional
retirement age. Again, we find evidence of heterogeneity in responses by education. The unemployment rate effect on working
longer is larger for less-educated individuals, while the house price effect is larger for more-educated individuals. This is
consistent with the fact that college graduates are less likely to be affected by business cycle fluctuations, and more likely to be
homeowners.
Conclusion
In this paper, we investigate the formation of expectations. We find evidence that suggests that HRS respondents update
their expectations in response to local and high frequency macroeconomic conditions in ways that seem to make sense, and
that this is stronger for respondents with higher levels of education. Our results provide an important contribution to our
understanding of how individual expectations are shaped by fluctuations in the macroeconomy.
University of Michigan Retirement Research Center
Institute for Social Research 426 Thompson Street Room 3026
Ann Arbor, MI 48104-2321 Phone: (734) 615-0422 Fax: (734) 615-2180
mrrc@isr.umich.edu www.mrrc.isr.umich.edu
The research reported herein was performed pursuant to a grant from the U.S. Social Security Administration (SSA) through
the Michigan Retirement Research Center (MRRC). The findings and conclusions expressed are solely those of the author(s)
and do not represent the views of SSA, any agency of the federal government, or the MRRC.
Regents of the University of Michigan: Julia Donovan Darlow, Laurence B. Deitch, Denise Ilitch, Olivia P. Maynard, Andrea
Fischer Newman, Andrew C. Richner, S. Martin Taylor, Katherine E. White, Mary Sue Coleman, Ex Officio